Assessing Recession

You don't need economists to tell you the economy stinks, not with layoffs increasing, energy prices climbing and unsold cars, computers and communications gear piling up. But you do need them to tell you when things are going to get better. When? That's what we asked TIME's Board of Economists. Their unanimous answer: Not right away. Even if the U.S. can steer clear of a recessionand one panelist says we may be
in one alreadythe economy will remain so weak for the next 12 months that to millions of Americans, conditions will still feel like a slump, particularly as unemployment rises. And it will rise.

Any outright recession should be short-lived, thanks to recent Federal Reserve rate cuts and rebate checks of up to $600 a household that families can expect by September, compliments of last month's $1.35 trillion, 10-year tax cut. (Singles without kids will receive about $300.) Richard Berner, chief U.S. economist for Morgan Stanley, says that while a recession may have got under way in the spring, the rebates should underwrite modest growth by this fall. (A recession is commonly viewed as two consecutive quarters of shrinking gdp.) Says Berner: "It's likely to be the shortest and mildest [contraction] on record."

What ails the economy, TIME's panelists agree, is the hangover from the irrationally exuberant investment binge that saw companies throwing money at all things high tech. That rocketed the rate of economic growth a year ago to a broiling annual pace of 5.6%. But when the overheated spending failed to produce juicy profits, corporate America suddenly cut back, bringing capital investment to a halt and lowering gdp growth to just 1.3% in the first quarter of this year. Today's high-tech investment numbers still look "monumentally awful," says Ian Shepherdson, chief U.S. economist for the consulting firm High Frequency Economics.

The cutbacks have already reversed some of the gains in productivity that had been touted as major achievements of the New Economy. Such gains stemmed from spending for technology that allowed a growing number of employees to work faster and smartera process that economists call capital deepening. But "as the investment boom goes bust," says William Dudley, chief U.S. economist for Goldman Sachs, "there is going to be less capital per worker, and you will lose that increment in productivity."

All that fancy new gear failed to warn of the present slowdown or keep companies from stockpiling unsold goods. (We have no "visibility," corporate chieftains declaim.) "If the decline in sales is dramatic," says Shepherdson, "all the technology isn't going to tell you it's coming."

The collapse of investment leaves it to U.S. consumers to take up the economic slack. They have done that so far despite a tech-stock implosion that has reduced household wealth and caused ceaseless price gyrations on Wall Street. Consumer spending has contributed some 90% of gdp growth in recent quarters. And consumers stand to get a big boost from what Berner calls "the most stimulative set of economic policies that we've seen in two decades"a reference to the tax cut and the five interest-rate reductions the Fed has made since January. While tax rebates in the past haven't done much to stimulate the economy, since consumers saved a huge chunk of the money, Berner says this time could be different. More of the rebates will be spent "because people will tend to view them as a down payment or an installment toward the permanent tax cut that's to come."

As more of that cut kicks in, Berner adds, the economy could grow at a vigorous 4% clip for much of next year. Dudley and Shepherdson are less optimistic, foreseeing growth of no more than 31/2% in 2002. "That's not to say that monetary and fiscal policies won't have any effect," Dudley says, "but they're pushing against some pretty powerful forces that are working to constrain economic activity."

No force is more potent than that of layoffs, which have been running at the rate of 6,000 a day, as companies struggle to hit profit targets demanded by Wall Street. This downsizing has jacked up joblessness from 3.9% in September to 4.4% in May. According to TIME's economists, 5% to 6% of the work force could be on the street by next year, the highest rate since 1996. "Cost cutting is the mode du jour," Berner says, "and it will continue for some time."

But that could prove to be a dangerous game since jobless workers are hardly big spenders. "If you really scare consumers," Dudley says, "then you have this whole downward dynamic of job losses leading to lower consumption leading to more job losses." Concurs Shepherdson: "The next stage of getting consumer confidence substantially higher is going to be the struggle against the head wind of rising unemployment."

Yet even with joblessness spreading and factories operating at just 77% of capacitythe lowest level in a decadeShepherdson said consumers are growing nervous about future inflation thanks to soaring gasoline and electricity prices and a surprisingly strong housing market. "Surveys of consumers suggest that inflation expectations have risen quite substantially," he says. And he is concerned that the Fed's rate cuts could leave the impression that the central bank no longer fears inflationa perception that could cause companies to agree to demands for big wage hikes.

The rest of TIME's panel sees scant danger of inflation heating up much beyond its current 3.4% pace. "The balance of power is shifting away from employees to employers," says Berner, "and we'll see that in terms of pay gains and the kinds of jobs that are available." Any drops in energy costs will also help keep inflation in check. Dudley expects crudeoil prices to fall from $28 a bbl. at present to "the low 20s" this summer, a decline that will deliver "a positive energy shock."

The amazingly sturdy U.S. dollar provides added insurance against any jump in the cpi. While a strong dollar can erode corporate profits by raising the price of U.S. exports, it also lowers the cost to Americans of everything that is imported from abroad, from cars to cameras. "It's been a boon to consumers," Berner says of the dollar, "because it keeps inflation down." He adds that the greenback should remain strong for the rest of the year because foreign investors "still view our markets as the most attractive in the world."

Looking further ahead, TIME's board expects the Fed to resume its antiinflation stance as the economy recovers and raise interest rates in 2002. According to Berner and Shepherdson, the central bank may do that as soon as next spring. While higher rates would raise the cost of mortgages, car loans and creditcard debt, they would also signal to Americans that the sharpest slowdown in a decade is behind them. It may be safe to feel more exuberant again.